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When the volatility don’t do what you think…

Submitted by Andrew Giovinazzi on Wed, 12/19/2012 - 4:15pm

Not the best grammar but I wanted an attention grabber.

Did anyone catch the volatility markup at the end of the day today? We had fairly solid preopening activity this morning, but news of the budget standoff sent the market into a small tailspin. The volatility players are in the serious business of trying to handicap the outcome of the Fiscal Cliff talks. Yesterday players were pricing in a much better shot of things going through earlier than not. VIX traded as low as 15.57, as it sold off most of the day yesterday. After an aggressive print on VIX settlement this morning, volatility traders started buying options in Jan cycle for the big indexes.

What I find interesting is how the buying played out. Normally, when you see a spike in IV and a market heading south, the paper is flying to the OTM puts. That steepens the skew curve on the downside. What we had today was something a little different. What you see in a 3D, curve graph below is that the upside today started to pick up more of a bid.

Looking at the highlighted area of the upside calls in the SPY, they were up 5% or more (dark green). You say big deal, but in the land of skew, they were moving more than their put counterparts. Relative moves are important when looking at index skew, and when the upside starts to outperform the downside on a big IV move, paper is buying calls, or at least, that is where the worry shifts.

If you caught our Option Pit Live daily webcast, we talked specifically about January options. The market is having a hard time pricing the gamma (a big up move possibly) with the vega (the attendant volatility crush). Paper just started buying calls, assuming today’s dip in stock prices was temporary. That is what I am going with. If you don’t believe the market thinks volatility is headed lower, just look at the Jan VIX future. Day one on the job as the spot month and it went backward with the full term ahead of it. Not exactly a rousing bid for juice.

The Trade

The simple trade is buying few SPY call spreads with the expensive skew. If you want MORE of a backspread ask Anna (anna@optionpit.com) for a copy of the Pit Report from today.

If you want to see it daily and be able to download our Pit Reports Anna can help with that too.

This is the type of training you will learn in our gold course. If you needed help following this trade, you should be in that course. Register here, or call us (888) for more info.